ETF providers take low-fee fight to new extremes

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The battle over basis points has begun.

Exchange-traded funds, long renowned for their low levies, are now vying to cut their skinny fees to nearly invisible levels in a market where the movement of billions of dollars in assets can hinge on a fraction of a percentage point.

Recent moves highlight the fierce competition among ETF providers for cost-conscious customers and demonstrate how much the investing market has changed. Investors who once tolerated mutual fund fees of two percentage points or more are now shifting assets depending on which provider can cut a few basis points – one hundredth of a percentage point – off already minuscule costs.

In the U.S. market, discount broker Charles Schwab Corp. recently slashed its fees on 15 ETFs, with some now charging a rock-bottom 0.04 per cent. BlackRock Inc., which operates ETF behemoth iShares, plans to lower fees on its offerings this quarter.

And Vanguard Group Inc., founded by indexing champion John Bogle, this week announced it will switch to cheaper indexes on a batch of U.S. and Canadian-listed ETFs to cut expenses and maintain its reputation as the low-cost leader.

"It's pretty clear that investors are focusing on costs," said John Gabriel, an ETF strategist at Morningstar Inc. "But it's a slippery slope to engage in the race to zero."

The rise of Vanguard has been one factor driving the recent fee cuts. Its share of the $1.3-trillion (U.S.) market grew by two percentage points over the past year, to nearly 18 per cent. BlackRock, which controls 40 per cent of the market but has been losing ground, is reacting to protect its turf, Mr. Gabriel said.

ETF providers are finding ingenious ways to cut costs. Vanguard has announced plans to migrate its funds from indexes compiled by MSCI to cheaper indexes licensed from London-based FTSE Group and the University of Chicago. "There is room for fees to go lower both here at Vanguard and in the industry," said its chief investment officer Gus Sauter.

Toronto-based Horizons Exchange Traded Funds Inc. has turned to a temporary fee cut to grab attention. It just sliced the rate charged by its Horizons S&P/TSX 60 ETF by 2 basis points to 0.06 per cent for the next 12 months.

The ETF, which has garnered $380-million in assets after two years, competes against the giant $12.8-billion iShares S&P/TSX 60 ETF, the Canadian industry pioneer, which charges 0.18 per cent. Both track the same index, but Horizons ETF does it through derivatives instead of holding the securities.

Mary Anne Wiley, managing director of BlackRock's Canadian subsidiary, reiterated the U.S. parent's plan to cut fees on selective ETFs. But she would not comment on whether the move will apply to iShares offerings in Canada, citing a "quiet period" before the firm reports its third-quarter results on Oct. 17.

Analysts suggest that one candidate ripe for a fee cut is the U.S.-listed iShares MSCI Emerging Markets ETF, which charges a hefty 0.67-per-cent fee when compared with Vanguard's MSCI Emerging Markets ETF at 0.20 per cent. The iShares offering "has lost billions" over several years to the rival Vanguard ETF, Mr. Gabriel said.

ETF fees won't go to zero, but they can get close if firms use them as loss leaders to attract business to other products, or find other ways of deriving revenue, such as lending securities in its ETFs to short sellers, Mr. Gabriel said.

Analysts warn that ETF investors should not necessarily jump into cheaper offerings. They need to check how closely an ETF tracks an index, and how long an ETF provider is likely to stay in business. Still, "all things being equal, they should pick the cheapest one around," said Todd Rosenbluth, an ETF analyst at S&P Capital IQ.

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Some of the cheapest equity-oriented ETFs:

*Fee dropped from 0.08 per cent for the next year. Source: Morningstar Inc., companies.